One person lending money to another

Read This Before Lending Money to Friends, Family

Over the years I’ve heard from dozens of readers who have lent money to friends and family members, only to have become outraged when the deal goes sour. The problem is they write to me after they’ve made the loan and have been waiting months, even years, for repayment, without success, hoping I can wave a magic wand to get their money back.

I always tell these readers that I wish they’d written to me before they lent the money. Doing things right from the start makes all the difference in the end. Here’s how:

 

One person lending money to another

1. Accept reality

Lend only the amount of money you can afford to give as a gift. Don’t tell your potential borrower this, but know in your heart that the chances of you ever being repaid in full are fairly slim. That’s a fact of life. There’s a reason this borrower is coming to you and not to a bank or conventional lender to borrow money.

2. Promissory Note

This is a legally binding document that when signed by both parties creates a contract. A Promissory Note lays out the details of repayment including total amount to be repaid, due dates and penalties if the terms and conditions are violated. Search for “free promissory note” online to find a form you can simply print out and fill in the blanks.

3. Reasonable interest

It is right for you and the borrower, that you charge a fair rate of interest. If your borrower balks at being charged interest, blame it on the IRS, which says you must charge an interest rate that is at least as high as the IRS’ Applicable Federal Rate, which is set monthly. Currently, that rate is 2.08%, and changes monthly.

4. Require collateral

You can require that your borrower “secure” this loan by pledging something of value that he or she owns, which has a perceived value of at least the amount of the loan. That could be a Rolex watch or a TV. Whatever it is, take possession of it. Hold it in lieu of repayment.

Include this statement of collateral in your documentation with a clear statement that once the loan is repaid, the collateral returns to the borrower. And should the borrower default, the collateral becomes yours to liquidate for repayment of the loan.

5. Formal repayment plan

Because you do not want to become a debt collector and deadbeat chaser, agree on a repayment plan up front before you hand over the money to your borrower. Do this while everyone is friendly and anxious to make this work. Let the borrower come up with a plan to which you can agree.

A great idea is for the borrower to arrange automatic deductions from his or her bank account to yours. Now you won’t have to wonder if the check is in the mail or if you’ll need to make yet another awkward phone call.

First published: 4-28-13; Revised & Updated 7-21-19

Question: Have you ever lent money to a friend or family member? Or were you the borrower? How is that working out for you? Click here to join in the conversation!


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  1. KKG4Life says:

    years ago I lent my older sister what was to me a considerable amount of money (with no interest because she was family and in need). This was in addition to buying her and her family expensive birthday and christmas gifts. Early on her ‘regular’ repayments became irregular then sporadic then occasional and I never pressed, expecting she’d do the right thing when she could. Instead, she announced one day that she’d paid me everything owed (she hadn’t come close). That was when I finally realized the pitfalls of personal loans, especially when family or close friends are involved. I never took issue over the loan but neither have I ever felt the same about her. Nor have I offered loans to friends who were in a tough spot though i wanted to and often felt guilty that I hadn’t. These are the worst effects of poorly thought out loans.

    Reply
    • js says:

      I will never understand how or why a family member thinks that it’s OK to screw another person over with money. My mother in law was loaned money and she too hasn’t paid it back. I will never feel the same way towards her again! She still owes $4500 from her loan. This has also soured my marriage in the process.

      Reply
      • Jan New says:

        We loaned our son $7,000 as well as another $800 for a rent deposit. We got maybe $4,000 back even though he believes he paid it all back. If I can gift money to him and his kids, I will. But, I won’t loan money to anyone anymore. I’ve pinched pennies all of my life and it’s not my fault that they weren’t more careful with what they had.

  2. aokimoonchild says:

    I think the article has good ideas to help make sure you get paid back, however I would personally advise not to lend money to anyone who is in a troubled financial situation. My son spent money like there was no tomorrow and he ended up at Xmas time broke. He asked me to lend him several thousand dollars and I said No, we settled on 500$ and he provided me a written payment plan (that was to start in January) which he has not honored, we are almost May and I have not received a dime back. I’m pretty sure I won’t see that money again.

    Reply
  3. Lisa says:

    I have been the borrower. My husband and I had a “side” business go sour, costing us thousands of dollars we didn’t have to spare. I hung my head and went to my Mom. She loaned us the money and we have automated payments to her deducted from our checking into hers each month. It makes it less painful for all of us!
    I agree that you should only borrow what you can afford to gift. Life is short and family and relationships are too precious to loose that over $.

    Reply
  4. Joyce says:

    Years ago I loaned a dear friend over $1000. to pay for water & electricity as her business was floundering. I never got it back and never will since she is now deceased. .. Lesson learned from this: I am not a bank. I can’t lend or co-sign anything financial.

    Reply
  5. katybee says:

    I loaned $3000 to one cousin last year and so far he’s making payments on time. I loaned some money to my other cousin in the form of credit card access and after 4 yrs. she still owes me about $450 and has not even made a payment in over a year. Another cousin borrowed $2300 for tuitionand so far has struggled to make even the minimum payments
    I feel so bad when I can help and don’t, yet at the same time I hate the role of the debt collector.

    Reply
  6. Guest says:

    Lesson learned! Fact: you really do need a signed promissory note (and I would suggest having it witnessed by a notary public) and outline of a repayment plan. I lent $4,500 to one of my daughters for tuition while she was in college with a verbal agreement that she would repay when she was out of school. This was money I had put aside for my graduate school tuition. Long story short, dear daughter moved out shortly thereafter, and will have nothing to do with us and three years have passed. She is out of school. She has told other family members that it was a “gift, not a loan”. No matter how close you are to that person or how trustworthy you think that person is, do what Mary suggests. I will never loan money to a family member again; a gift, perhaps, but never a loan.

    Reply
  7. Bush Brengelman says:

    I loan to my sisters and have them give me post dated checks for the amount of each payment. They can call and ask me to hold it a week, but this way I’m not having to call them.

    Reply
  8. Marietta GA BBB says:

    I once had a neighbor ask to borrow $450 to pay her power bill. She was moving out soon and couldn’t get power turned on in her new home without first paying the bill in the old. I finally agreed to the loan provided she would sign a promissory note and give me some collateral. I got the text of the note from the local library (pre Internet days). For collateral, she gave me a diamond ring that had belonged to her mother. The ring, she said, was worth $8k.

    I paid the power bill for her, and waited two weeks for payback. She did make good on her promise. I felt if I hadn’t had the ring, she would have had no incentive to pay me back. It all worked out in the end, but it created a very awkward circumstance. I have never loaned money to a friend again, but I did loan money to a family member once and never saw it again. At that time, I didn’t get a promissory note. Lesson learned!

    Reply
    • discus/watchdog for God says:

      I lent a large sum of money to a son. He needed it for a down payment on a house as he was soon to be married. This was totally against my better judgement. I had a promissory note drawn up by an attorney with payment schedule with a clause that I could take court action if it wasn’t paid by a certain date. He signed it. It’s been 15 yrs and it still isn’t paid. He and his wife keep stopping payments because of job changes, new baby etc, etc. I’m really upset about this and feel so stupid and betrayed. It’s been 5 yrs since there was any payment made. There will be showdown very soon as I am so finished with this.

      Reply
      • tboofy says:

        He probably didn’t have anything to put down as collateral, but you can see how that is an important part of the equation. Not that I’m any better. I’ve “loaned” to my dad and my brother and never seen a penny back–except when I let my brother use my credit card and they made the payments on that…but it took years for them to pay off. They were never late (I made sure), but my credit score went up like 30 points once they finally paid it off.

  9. Beck says:

    I loaned money to my sister who eventually went bankrupt. Her problems were mostly due to a doctor who prescribed numerous prescriptions that led her to having some sort of impairment. If we would have known this was going on (she lived four hours away) we would have called the Dr. or reported him and the small town pharmacist that kept filling all of them he should have caught how much she was taking as well. By the time she moved back home and got off all the meds the Dr. had retired. I was never paid back which was fine as she passed away from a stroke a few years ago. Her wish was to pay back all of us siblings supposedly in her will but her executors said she lost the will and kept the money. There was life insurance and retirement that could have been used to pay relatives back it just didn’t happen. It was not worth contesting it since they were also family. So I agree when you lend to relatives you might as well figure you are not going to be paid back.

    Reply
  10. Lori M says:

    The amount you can gift tax-free has gone up. For 2013 it’s $14,000. http://www.bankrate.com/finance/taxes/estate-tax-and-gift-tax-amounts.aspx

    Reply
    • Guest says:

      Thanks, for that correction, Lori. The principle, however, remains as stated. The IRS assumes you will be earning interest and will penalize you as such if you do not report it.

      Reply
      • DianaB says:

        This is considered a gift, not a loan. IRS does assume you will be earning interest on a financial gift.

      • DianaB says:

        Sorry, meant the IRS does NOT assume you will be earning interest on a financial gift. This gifting is basically meant to lower your financial assets for estate purposes, nothing more. It is not considered a loan in any way. Otherwise, for tax purposes, you can try writing it off as “bad debt” if it is not repaid.

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